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“This is our best quarter ever!” said Salesforce.com (NYSE: CRM) CEO Marc Benioff during the company’s second-quarter earnings call on Thursday. After a tough day for tech stocks, Salesforce shares rose in after-hours trading following the release of a Q2 earnings report that exceeded Wall Street expectations.
Salesforce reported earnings of $0.19 per share, when the expectation was for $0.18. Q2 revenue was $1.63 billion. Salesforce is projecting revenue growth between 22% and 23% for its current quarter. Furthermore, the company reported strength in its sales pipeline and raised the revenue expectation for the full year.
During the earnings call Benioff stated, “We are well on our way to accomplishing our goal of being the fastest company ever to $10 billion in revenue.”
Has SaaS Model Been Proven?
Salesforce made its name from customer relationship management (CRM) services. It is a pioneer in the software as a service (SaaS) business model. Salesforce’s software is used by salespeople to manage sales leads and track deals.
Prior to Salesforce, software companies sold programs that would be installed directly on the customer’s computer. Salesforce popularized the SaaS approach, in which customers access the software through Salesforce’s’ data centers, or what has been termed the cloud. The customers purchase a subscription to the service at a lower upfront cost, but remain a customer longer, so theoretically they will generate more revenue over time.
However, about half of Salesforce’s revenue has been spent on sales and marketing to propel its long record of revenue growth. This is a trend among other SaaS companies as well, like Box Inc. (used for file sharing) and Zendesk (a customer-service software company). These companies also spend as much as half (or even more) of their total revenue toward sales staff and other related marketing costs to fuel high growth rates.
Venture capitalists and investors are gobbling up SaaS companies, but the question still remains: Is there an inherent flaw in the SaaS business model that will prevent it from ever being as profitable as the traditional software company?
Salesforce and other SaaS companies pride themselves in exceptional customer relationships, but exceptional customer service also comes with a high price and long sales cycle.
Changing Tactics and Expanding Markets
Once a novel way of doing business, SaaS is becoming a standard offering from large companies like Microsoft (NASDAQ: MSFT) and a mass of fresh startups.
Now, Salesforce is working to launch new industry-specific clouds that will further entrench current customers into its network.
There is an increased demand for these more customized applications. In the earnings call, Benioff noted that the support sites for Home Depot (NYSE: HD) and Sony PlayStation are among those using the Salesforce Service Cloud for customer support.
This expansion into industry-specific, customized applications means Salesforce is more than a sales force automation (SFA) company.
And Salesforce isn’t alone in this push to strengthen its stronghold with existing clients. Other large competitors like Microsoft, Oracle (NYSE: ORCL), and SAP SE (NYSE: SAP) are chasing the same opportunities to expand their offerings to current customers.
What Does This All Mean?
If Salesforce can pull of this new expansion, then it may still prove that the SaaS model is viable. The company has been reining in sales and marketing expenses, which dropped from 53.3% of revenue in the fiscal year ending Jan. 31, 2014 to 49% in the quarter ending on July 31.
My recommendation: buy Salesforce stock. It’s finally figuring out how to make SaaS really work. By beefing up its offerings to current customers and bringing down high sales costs, Salesforce has a chance to prove that SaaS is a viable business model.
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